The way individual retirement account (IRA)withdrawals are taxed depends on the type of IRA. For example, you'll always pay taxes on traditional IRA withdrawals. But with a Roth IRA, there is no tax due when you withdraw contributions or earnings, provided you meet certain requirements.
Early withdrawals—those that happen before age 59½—from any qualified retirement account, including IRAs and 401(k) plans, come with a 10% penalty. Early withdrawals also trigger income taxes on the distributed amounts, though there are some exceptions to this rule.
Key Takeaways
- Contributions to traditional IRAs are tax deductible, earnings grow tax-free, and withdrawals are subject to income tax.
- Roth IRA contributions are not tax-deductible, earnings grow tax-free, and qualified withdrawals are tax-free.
- Because contributions to Roth IRAs are made with after-tax money, you can withdraw them at any time, for any reason, with no tax or penalty.
- Early withdrawals (before age 59½) of funds from a traditional IRA—and earnings from a Roth IRA—are generally subject to a 10% penalty, plus taxes, though there are exceptions to this rule.
How Traditional IRA Withdrawals Are Taxed
With a traditional IRA, withdrawals are taxed as regular income (not capital gains) based on your tax bracket in the year of the withdrawal. As of 2023, there are seven federal tax brackets in the U.S., ranging from 10% to 37%.
Both traditional and Roth IRAs are subject to the same annual contribution limits. The limit is $6,500 for 2023 (up from $6,000 in 2022). If you are 50 or older, you can contribute an additional $1,000catch-up contribution (for a total of $7,500 in 2023, up from $7,000 in 2022).
The idea is that you are subject to a higher marginal income tax rate while you are working and earning more money than when you have stopped working and are living off of retirement income. Of course, this is not always the case.
Qualified Traditional IRA Withdrawals
Although withdrawals are taxed the year you make them, there are no additional penalties if you're at least 59½ or use the funds for a qualified purpose.
Qualified purposes for an early withdrawal from a traditional IRA include a first-time home purchase, qualified higher education expenses, qualified major medical expenses, certain long-term unemployment expenses, or if you have a permanent disability.
Deducting Traditional IRA Contributions
Traditional IRA contributions can be fully or partially tax-deductible based on your modified adjusted gross income (MAGI) if you contribute to an employer-sponsored plan, such as a 401(k).
For 2023, the phase-out range (where you begin partial deductions) is increased to between $73,000 and $83,000 (up from between $68,000 and $78,000 in 2022), and for married couples filing jointly, the phase-out range is increased to between $116,000 and $136,000 (up from between $109,000 and $129,000 in 2022). Unlike Roth IRAs, there are no income limits on who can contribute to a traditional IRA.
Traditional IRA holders (and 401(k) plan participants, too) who are 73 years and older must take required minimum distributions (RMDs), which are subject to taxes.
How Roth IRA Contributions Are Taxed
Because you make Roth IRA contributions with after-tax dollars, you can withdraw them tax-free at any time with no tax or penalty. But this also means contributions are not tax deductible like those made to traditional IRAs are. And keep in mind that you can only contribute earned income to a Roth IRA.
Earned income is money you receive for working, such as wages, salaries, bonuses, commissions, tips, and net earnings fromself-employment. Conversely, income derived from investments and government benefit programs is considered unearned income.
Qualified Roth IRA Withdrawals
You can withdraw earnings without penalties or taxes as long as you’re 59½ or older and have had a Roth IRA account for at least five years. Although it can be hard to predict, a Roth IRA may be a good choice if you think you will be in a higher tax bracket when you retire.
Like a traditional IRA, you can avoid the 10% penalty for early withdrawals if you use the money for a first-time home purchase, qualified education expenses, medical expenses, or if you have a permanent disability. However, you might still pay taxes on the amount withdrawn, depending on how long it's been since you first contributed to a Roth.
Roth IRA Income Limits
Not everyone is eligible to contribute to a Roth IRA. Unlike a traditional IRA, there are income limits. For 2023, only individuals with a MAGI of $153,000 (up from $144,000 in 2022) or less are eligible to participate in a Roth IRA. The phase-out for singles starts at $138,000 in 2023 (up from $129,000 in 2022).
For those married filing jointly, the 2023 MAGI limit is $228,000 (up from $214,000 in 2022),with a phase-out starting at $218,000 ($204,000 for 2022).If you earn too much to contribute to a Roth directly, you might be able to make contributions indirectly via a strategy known as a backdoor Roth IRA.
How Much Tax Do You Pay on IRA Withdrawals?
That depends on several factors, including the type of IRA, your age, and how long it's been since you first contributed to an IRA. If you have a Roth IRA, you can withdraw your contributions at any time with no tax or penalty. To withdraw your earnings, you must wait until you're 59½ or older, and it's been at least five years since you first contributed to a Roth IRA to avoid taxes and penalties.
Withdrawals from traditional IRAs are subject to income taxes at your ordinary tax rate, and early withdrawals may be subject to a 10% penalty tax. There are exceptions to the rules that allow early withdrawals without triggering the penalty and taxes.
When Do RMDs Start?
RMDs only apply to traditional IRAs; there are no RMDs for Roth IRAs during the account owner's lifetime. The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) raised the RMD age from 70½ to 72. The Consolidated Appropriations Act of 2023 raised the age for RMDs to 73 for anyone born between (and inclusive of) Jan. 1, 1951, and Dec. 31, 1959. The age increases to 75 for anyone born Jan. 1, 1960 or later.
How Are RMDs Calculated?
RMDs are generally calculated by dividing the account's prior Dec. 31 balance by the appropriate life expectancy factor the IRS publishes in Publication 590-B, Distributions from individual retirement arrangements (IRAs). You must calculate the RMD separately for each IRA you own, but you can withdraw the total amount from one or more IRAs.
The Bottom Line
The withdrawal rules for IRAs depend on the type of IRA, your age, and how long it's been since you first contributed to an IRA. In general, Roth IRAs offer more flexibility because you can withdraw your contributions at any time, qualified withdrawals are tax-free, and they aren't subject to RMDs during the account owner's lifetime.
On the other hand, traditional IRA withdrawals are taxed at your ordinary income tax rate, and you must start taking RMDs the year you turn 73. The penalty for not taking RMDs is steep: Whether you fail to take the RMD by the deadline or don't withdraw enough,the amount not withdrawn is taxed at 25%. You might be able to have the penalty reduced to 10% if you fix the issue within the correction window, which generally begins on Jan. 1 of the year following the RMD mistake.
